How does the money creation process work in Canada?

The Loans officer is satisfied with the borrower’s ability to repay the loan. The loans officer simply types those numbers into a data base, thus creating $1000.00 of brand new digital money (Creating the principal amount), this money does not come from anywhere. There are 2 entries, otherwise known as expanding the balance sheet; One on the asset side of the bank’s balance sheet under Loans/Personal, and the other on the liabilities and equity side of the balance sheet under Deposits/Personal.

Commercial Bank Balance Sheet

Assets/Loans/Personal Liabilities and Equity/Deposits/Personal

$1000.00 $1000.00

The borrower then takes out a $1000.00 in cash: Now the bank removes $1000.00 from the asset side of the balance sheet and $1000.00 from the liabilities side of the balance sheet. However, the loan is still outstanding and must be paid back at some point.

Assets/Cash and deposits with banks Liabilities/Equity/Deposits/Personal

-$1000 -$1000

The borrower earns $1100.00 and deposits it into his account:

Assets/Loans/Personal Liabilities and Equity/Deposits/Personal

$1000.00 $1100.00

The borrower repays the loan plus interest digitally (not cash), the loan is removed from the balance sheet (The principal is destroyed) and the interest is removed and entered into the statement of income under net interest income:

Assets/Loans/Personal Liabilities and Equity/Deposits/Personal

$0 $0

What happens if the customer repays the loan with cash? The cash cannot be destroyed so where does it go?

The cash is then moved to "Cash and deposits with banks"on the asset side of the balance sheet plus the same actions that were employed in the previous step including the difference (the interest paid) in Equity/retained earnings on the liability side of the balance sheet.

This is a simplified version of a balance sheet in order to illustrate the money creation and destruction process and is based on terminology used by the Canadian Imperial Bank of Commerce (CIBC). Other changes in the balance sheet as a result of these transactions are not shown.

Conceptually the most important thing to understand is that privately owned commercial banks have been given the right to create money by the government of Canada. In addition, because they are a for profit business their interests do not always coincide with the interests of the Canadian public. Go to the "Current System Problems" page for a more in depth analysis or read "The Costs of Money Creation and Complexity." https://progressivemoney.ca/letter-to-parliament

Learn More

If your curiosity has been piqued the next step is to debunk money lending myths. I am sure you have heard before that banks simply lend out a portion of savings or other assets that are not currently being used. Ask yourself has your deposit account at your local bank suddenly dropped inexplicably? Have any of your friends or family ever experienced this? If the answer is no then where does this new money come from?

Are there limits to the amount of money a bank can create?

Privately owned commercial banks are never allowed to create paper money, that is the sole right of the Bank of Canada. Theoretically the amount of digital money that privately owned commercial banks are permitted to create depends on the bank's assets relative to its liabilities. Also, higher capital adequacy ratios provide more resiliency and are critical in ensuring that banks have enough cushion to absorb a reasonable amount of losses before they become insolvent and consequently lose depositors' funds.

However it is likely that banks extend credit and then go looking for the required CARs given research into past activities of banks when there were reserve requirements.

Prior to July of 1994 there were reserve requirements meaning that commercial banks were required to hold a certain percentage of reserves relative to the amount of liability deposits which is consistent with the money multiplier model in macroeconomic textbooks.

However, empirical research initiated by Basil Moore (1979, 1983, 1988a, 1997, 2001) and later independently corroborated by numerous researchers, including Kydland and Prescott (1990), confirmed a simple operational observation about how banks actually operate, made in the very early days of the monetarist controversy, by the then senior vice-president of the New York Federal Reserve, Alan Holmes. The ‘Money Multiplier’ model assumes that banks need excess reserves before they can make loans. The model process is that first deposits are made, creating excess reserves, and then these excess reserves allow loans to be made, which create more deposits. Each new loan reduces the level of excess reserves, and the process stops when this excess has fallen to zero.

deposits. If the level of loans and deposits then means that banks have insufficient reserves, then

they get them afterwards – and they have a two-week period in which to do so.

In contrast to the Money Multiplier fantasy of bank managers who are unable to lend until they receive more deposits, the real-world practicality of banking was that the time delay between deposits and reserves meant that the direction of causation flowed, not from reserves to loans, but from loans to reserves.

Capital Adequacy Requirements

The main reason for publishing this video is to emphasize the complexity of the capital adequacy requirement ratios and the limitations of it. It's a little over 14 minutes long and hits on some key points that make the video worth watching. The downside is that you are forced to look at my face and listen to me stumble along. Below the video is the pdf document that I was reading from.

Money creation in Canada and the United Kingdom

Positive Money is a monetary reform group based in the U.K., they published this video on money creation. However the Canadian system works the same way, the names of assets and liabilities on banks balance sheets will differ slightly.

Money Creation by Michael Kumhof

Bank of England, Michael Kumhof is Senior Research Advisor in the Research Hub. He is responsible for co-leading this new unit, and for helping to formulate and carry out key parts of its research agenda. His previous position was Deputy Division Chief, Economic Modelling Division, IMF, where his responsibilities included the development of the IMF’s global DSGE simulation model.

Money creation in the Modern ecomomy

The following PDF "Money Creation In The Modern Economy" was a document published by the Bank of England in the first quarter of 2014. It provides more detail into the accounting aspect of modern banking.